There seems to be little question that the Federal Reserve will cut its target rate when the open market committee meets on Tuesday. The open question now seems to be how much the Feds will cut.
On Friday, after a much weaker than expected jobs report, Goldman Sachs said that a 50 basis point cut was the most likely outcome. But some are calling for much steeper cuts. PIMCO’s Paul McCulley has called for a 100 point cut. Economist Martin Feldstein, told the Fed conference in Jackson Hole, Wyoming that a fall in housing prices would likely reduce consumer spending and set-off a recession unless the Fed cut 100 basis points.
Until recently that kind of interest rate cut may have seemed outlandish—and remains unlikely—but several Fed honchos have recently voiced concerns about employment and consumer spending. Just this afternoon Federal Reserve Bank of Atlanta President Dennis Lockhart said consumer data will play a key role in the Fed’s decision on interest rates. Another Fed official, who doesn’t get a vote but who is regarded as influential among those who do, said that “downsides risks” to the economy from financial market turmoil are greater than previously thought.
Another factor that may indicate a deeper rate cut is that the Fed seems to have already implemented a ‘stealth cut’ by using its debt buying capacity to hold interest rates below the 5.25% interest rates. If the economy is still under pressure despite the stealth cut, the Fed may feel it needs to cut rates by at least another notch, down to 4.75%, to avoid a recession.
No matter what the Fed does, it will likely face sharp criticism. The sound money crowd will worry that the Fed cuts will only encourage further misallocation of capital, obscure errors of the past, and create the risk of a more serious downturn in the future. Some of the easy money folks will say the Fed waited too long to implement a cut. And this morning we spoke to a high level executive at a major Wall Street firm who believes the Fed’s stealth cut has damaged its credibility beyond repair. He thinks Bernanke has to go before the markets will have confidence in his leadership.
“They need to stop lying and stop playing games,” he said just a few moments before asking us not to name him or his employer.
Fed Officials Say Uncertainty Remains [Wall Street Journal]
Fed should cut rates by 100 bps by 2008, says PIMCO [Reuters]